After TVIX, Time To Fix ETF Creation Process, Rosenblatt Says

By Brendan Conway

Would last month’s boom-and-bust in a leveraged Credit Suisse (CS) product have been more orderly with stricter rules over how new ETF and ETN shares are created? Rosenblatt Securities’ Steve Williams sure thinks it could have helped. He argues that the real TVIX lesson applies to the entire ETF industry and isn’t specific to ETNs, which have gotten considerable heat the last several weeks.

In a new client note, Williams says that there are “hours or days” in between when creation-and-redemption orders are made and their disclosure on data services like Bloomberg and Reuters. He considers the creation-and-redemption process to be far too opaque, a quality that invariably helps sophisticated traders and harms those who aren’t in the know. To read Williams you’d think regulators should take a hard look at ending this time window between orders and actions. It might reduce the chance that well-informed traders get ahead of the pack.

Reuters

More disclosure, please.

Recall we’re talking specifically about the VelocityShares Daily 2X VIX Short-Term ETN (TVIX), where new creation units were cut off by the investment bank in February. That cutoff, which was announced quietly in an after-hours press release, created a huge artificial premium in TVIX’s price. The air came out of the balloon in two fast sessions late last month when CS re-opened creations on a partial basis. It was entirely up to CS when to take that step, which was one source of frustration for the smalltime traders who bought the product and later professed ignorance of the premium.

The bigger issue may be the pretty powerful if circumstantial evidence that the timing of the creation announcement got out into the market. The price action ahead of the news, Williams observes, “strongly suggests that traders learned of, or anticipated, the impending creation well in advance of Credit Suisse’s announcement, and positioned themselves accordingly.” Here’s a look at Williams’ tick-tock on the TVIX events, plus more flavor on his view of the creation-and-redemption issue:

Credit Suisse announced at 7:30 pm March 22 that it would resume creation of TVIX shares “on a limited basis.” And sure enough, Bloomberg data indicate that 6mn shares were created on March 23. But TVIX’s market price and premium to indicative NAV began to collapse, on heavy volume, just after 11 am on March 22. That kind of price action strongly suggests that traders learned of, or anticipated, the impending creation well in advance of Credit Suisse’s announcement, and positioned themselves accordingly. TVIX issuer Velocity Shares says it must receive creation orders by 12 pm on the day before shares are created, in order for them to be struck at the previous day’s closing price. In other words, Credit Suisse would need to have delivered to Velocity Shares the order for the 6mn TVIX shares it created on March 23 by 12 pm on March 22 — shortly after the swoon in TVIX began.

It will be fascinating to see how time fills in the blanks on this one. But one thing is clear now — there’s simply too much opacity surrounding create-and-redeem, especially considering how much the process influences market prices. Creation-and-redemption orders are often sent hours or days before the information is made available to sources like Bloomberg or Reuters.

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There are 4 comments

APRIL 17, 2012 7:55 P.M.

John P wrote:

Its so easy to check the nav on these products, what more transparency could you want? So we are going to make more rules up for people because they were not smart enough to research their choice of trading. This etp is not an investment. It's a gamble and at best a short term hedge. The issuing bank even states not for unsophisticated investors and that long term value of fund is zero. Being that the potus has his speeches written to a ninth grade level so most can understand him, I believe this rules out most of America from using this etp. Besides with uvxy etf which is more accountable and its ability to buy options should render tvix obsolete

APRIL 19, 2012 4:00 P.M.

Anonymous wrote:

I suggest that Mr. Williams should check with the issuer regarding the creation/ redemption process prior to writing about it. Mr. Conway, this is Barron's, please do your homework.

The below comments are incorrect.

"TVIX issuer Velocity Shares says it must receive creation orders by 12 pm on the day before shares are created, in order for them to be struck at the previous day’s closing price. In other words, Credit Suisse would need to have delivered to Velocity Shares the order for the 6mn TVIX shares it created on March 23 by 12 pm on March 22 — shortly after the swoon in TVIX began."

APRIL 20, 2012 4:04 P.M.

Steven Williams wrote:

It's not clear exactly what anonymous finds questionable. We spoke directly with velocity shares to understand their policies on creating and redeeming shares, and the required notice periods. All other data came from bloomberg. We stand by what we wrote.

Steven Willims
Rosenblatt Securities

APRIL 22, 2012 11:36 P.M.

GamblingIsIllegal wrote:

If gambling is illegal except in casino, why they allow this kind of gambling to be freely and easily done by the general public. If it's so sophisticated, put it in casino and let the pro gamblers do it. Don't let it be quoted just like any investment.

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Chris Dieterich has covered the U.S. stock market for The Wall Street Journal and Dow Jones Newswires. He is a graduate of Regis University and the Missouri School of Journalism.